Patrick McKenna, Deputy Head of Multi‑Management, Mediolanum International Funds, writes that emerging markets have long been treated as a natural source of diversification in global portfolios.
For many investors, simply owning the benchmark has been seen as a straightforward way to capture growth across a wide set of countries. But the structure of today’s emerging market indices tells a more complicated story. What looks like broad exposure often turns out to be a narrow collection of large countries, dominant sectors, and politically influenced companies. As passive investing becomes more widespread, these underlying patterns matter more than ever, and they are making a stronger case for active management.
A good starting point is the idea of diversification itself. The major emerging market benchmarks are shaped by a small number of countries and a handful of large companies, many of which are heavily involved in technology. When passive flows track these indices, they reinforce the same concentration that investors assume they are avoiding. The result is that a supposedly diversified allocation can end up tied closely to the fortunes of a few political systems, regulatory environments and industrial strategies. Many investors are surprised when they discover how much of their “broad” emerging‑market exposure is effectively a bet on a small cluster of markets.
The growing influence of politics on market outcomes
The political dimension adds another layer of complexity. In emerging markets, the state often plays a more direct role in shaping corporate outcomes. Policy shifts, regulatory interventions, and geopolitical tensions can move entire sectors quickly and sometimes unpredictably. The ongoing realignment between the US and China, the re‑routing of global supply chains, and the growing use of sanctions all create risks that do not show up in a benchmark weight.
Passive vehicles are less able to distinguish between companies operating with genuine commercial independence and those whose decisions are influenced by political priorities. Active managers, by contrast, can make those judgments and adjust portfolios as conditions evolve. In markets where political direction can reshape industries overnight, that flexibility matters.
How passive adoption is reshaping market structure
Another important trend is the feedback loop created by the rise of passive investing itself. As more capital flows into index‑tracking strategies, index weights increasingly determine where liquidity forms. Large markets attract more inflows simply because they are large, while smaller or reforming markets struggle to attract attention even when fundamentals are improving. This can distort price signals and widen the gap between the most visible parts of the index and the rest of the investable ecosystem. Active managers can step into these overlooked areas, applying research and judgement to identify companies whose prospects are not yet reflected in benchmark composition.
All of this is happening at a time when emerging markets are becoming more diverse. The idea of a single, unified “emerging‑market story” has been fading for years, but the divergence is now more pronounced. Technology‑driven exporters are moving in a different direction from commodity‑dependent economies. Countries pursuing structural reform are separating from those where the state is tightening its grip.
Some markets remain highly sensitive to the US dollar, while others are building buffers to reduce that dependence. Treating these very different regimes as interchangeable can lead to exposures that do not match an investor’s intentions. Active management allows for a more deliberate approach, one that recognises the growing distance between these paths.
What this means for portfolio construction in 2026
For advisers and allocators, the central question in 2026 is not whether active management can outperform a benchmark in any given year. The more relevant question is what risks a portfolio is actually taking. Benchmark exposure carries assumptions about governance, currency, political direction, and capital discipline. These assumptions may be acceptable, but they should be understood rather than inherited by default. Active management offers a way to bring clarity and intentionality back into emerging‑market allocations.
Three practical considerations are becoming increasingly important. The first is understanding concentration. Knowing which countries and sectors dominate an allocation helps investors see whether their exposure matches their expectations. The second is assessing governance. Capital discipline, minority‑shareholder protection, and the degree of state influence vary widely across emerging markets, and these differences have real implications for long‑term returns. The third is thinking in terms of risk budgets rather than benchmark weights. In more volatile environments, the ability to limit drawdowns or avoid politically exposed companies can be just as valuable as capturing upside.
The broader debate around active and passive investing is also evolving. Cost remains an important factor, but it is no longer the only one. In developed markets, where dispersion is often lower and governance frameworks are more consistent, passive strategies can offer efficient exposure. In emerging markets, the landscape is more uneven. Political shifts, governance variability, and structural dispersion create an environment where oversight and selectivity can add meaningful value. Active management is not a guarantee of better returns, but it is a way to navigate complexity with more control and more awareness of the risks being taken.
This evolving landscape expands the opportunity set. Greater dispersion across countries and sectors increases the potential for differentiated outcomes, strengthening the role of stock selection. In markets where benchmarks remain concentrated and flows are automatic, mispricings can persist, giving disciplined active managers more room to capture excess returns through selective capital allocation. Periods of structural change and political realignment often broaden performance opportunities, even as volatility rises.
Looking ahead
Looking ahead, volatility is likely to remain elevated and political differentiation across emerging economies is set to widen. In that environment, relying solely on benchmark exposure may leave investors with risks they did not intend to take. Selectivity is becoming more important, not less, and active management offers a way to engage with emerging markets on their own terms rather than through the lens of a single index.
